Sunday, March 30, 2014

Wow, what a show of strength by the bears! By the end of last week, the blogosphere came alive with buzz about the technical damage done to the major US equity averages. My inner investor is getting more cautious, though my inner trader thinks it may be premature to get aggressively short the stock market.

On the surface, the SPX didn't look too bad. It had descended to a major support zone and remained above the 50 days moving average (dma). The 5-day RSI (bottom panel), which is useful for short-term swing trading, showed fading momentum. Bulls could be comforted by monitoring how the index would behave in the support zone pictured in the chart below.

The carnage was mirrored in the formerly red hot Biotech stocks. If it is any consolation, bulls can at least point to the fact that the Biotechs were testing a relative uptrend line that began about a year ago.

Unfortunately, the same couldn't be said of the NASDAQ Internet Index, which consisted of momentum technology names such as Amazon.com, Google, Facebook, etc. The chart of their relative performance to the SPX showed a violation of the relative uptrend line, with little support beneath current levels. There is a glimmer of hope as the decline could be arrested at one of the pictured Fibonacci retracement levels.

The damage was also evident in the NASDAQ Composite. The top panel of the chart below shows that COMPQ had breached its 50 dma and it was testing the the bottom of a support zone. The chart of the relative performance of COMPQ against the SPX is more troubling as it shows that these high-beta stocks had violated a relative uptrend line, which is indicative of declining risk appetite.

The chart of the small cap Russell 2000 also shows a similar picture of the violation of the 50 dma and relative uptrend line, as well as a test of the low end of the range of a secondary support zone.

The relative performance of the Consumer Discretionary sector against Consumer Staple sector, another measure of risk appetite, reveals a violation of the relative uptrend that began in early March. This pair is now testing the bottom range of a relative support zone.

Other measures of risk appetite, such as this chart of the relative performance of the SPX against long Treasuries, tells a similar story. This pair violated a relative uptrend line in January, consolidated sideways and now it is again testing an area of relative support.

I could go on about how market internals have deteriorated and risk appetite has waned, but you get the idea.

Time to get short?
With the bears swarming the equity markets like Russian troops in the Crimea, is it time for aggressive traders to get short this market? My inner trader is whispering, "Not yet."

Despite the carnage, stock prices seem to be following the script of a mid-term election closely. Ryan Detrick tweeted this chart on March 17 and the market seems to be still following the historical pattern of a rally into April/May. If history is any guide, late March and early April tends to be sloppy and the market stages one final rally in late April before topping out and decline into a final low in October.

Given the kind of technical damage that has been done, it's doubtful that stock prices are capable of making a new high in April or May. Bears should consider that high-beta assets are highly oversold and could stage / a counter-trend rally at any time. As well,.the market have experienced numerous breaks of uptrends or relative uptrends. However, trend breaks tend to resolve themselves in a period of sideways consolidation, rather than an immediate trend reversal. Consider this classic example of the relative performance of the NASDAQ 100 against the SPX in the last 15 years. NDX underwent both a relative uptrend and relative downtrend and, in both cases, the relative breakout and breakdown were followed periods of consolidation.

While I am tilting bearish for the next few months, I would be hesitant about making a major commitment to get short here. Consider what could go right for the bull camp:

Earnings Season is just around the corner and the results could be a wildcard. The Citigroup US Economic Surprise Index is near the bottom of its near term range and has started turn up. Such a reversal could translate into better company guidance as we move through Earnings Season, which would be bullish for stocks. The first key test for bulls and bears alike will be the jobs report on Friday. Anyone putting on a major bearish position here would be betting that the Economic Surprise Index continues to deteriorate and growth starts to decelerate to sub-2% levels - a truly non-consensus call.

Watching for the bearish trigger
In conclusion, the intermediate term bias for stock prices is down, but my inner trader remains wary of being overly aggressive in taking a short position here. He is watching the following trading model as one of the conditions to get short. The model is based on the readings of the SP 500 HiLo Index (real-time updates here):

SPXHLP is negative (indicates short-term negative momentum)

The 10 dma of SPXHLP is less than 5 (indicating that the trend is down)

The vertical lines in the above chart shows the past instances where these signals have been first triggered. In most cases, the signals have been a little late but they have been the precursors of further declines in stock prices. For now, neither the SPXHLP nor its 10 dma are at their bearish trigger points, indicating that it is premature to go short.

There are a number of caveats to the use of this model. First and foremost, it has not been tested in real-time and the chart is only based on back-tested performance, so take its output with a grain of salt. As well, the tests show that it is useful on timing the entry point to go short, but it is less useful on exit conditions.

I am offering this trading model to my readers for free. Its value is measured by the price paid.

Most of all, remember that the signals from this untested model should not be the only trigger for making a trading decision.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Wednesday, March 26, 2014

When I started this blog, I had been advocating that quantitative analysts think long and hard about the underlying assumptions of their models, otherwise known as conducting a "sanity test" on model results. Cullen Roche of Pragmatic Capitalism recently said the same thing when he wrote about the limitations of economic models. He believed that economists overly obsess over the mathematical elegance of their models (emphasis added):

And that’s the key. I think that economic modelling is very useful. It helps conceptualize important points and gives us a general framework for understanding the world. But we should also be aware of the weaknesses embedded in many of these models because many of these models are simplified to the point that they are misleading. And this stems from another big problem revolving around the way many economists obsess over mathematics.

Regression blindness
Frances Woolley at Worthwhile Canadian Initiative complained about the same kind of blindness from her students. They focus too much on technique, rather than what they are trying to explain, in light of the problems with the data:

People make elementary errors when they run a regression for the first time. They inadvertently drop large numbers of observations by including a variable, such as spouse's hours of work, which is missing for over half their sample. They include every single observation in their data set, even when it makes no sense to do so. For example, individuals who are below the legal driving age might be included in a regression that is trying to predict who talks on the cell phone while driving. People create specification bias by failing to control for variables which are almost certainly going to matter in their analysis, like the presence of children or marital status.

But it is rare that I will have someone come to my office hours and ask "have I chosen my sample appropriately?" Instead, year after year, students are obsessed about learning how to use probit or logit models, as if their computer would explode, or the god of econometrics would smite them down, if they were to try to explain a 0-1 dependent variable by running an ordinary least squares regression.

I try to explain "look, it doesn't matter. It doesn't make much difference to your results. It's hard to come up with an intuitive interpretation of what logit and probit coefficients mean, and it's a hassle to calculate the marginal effects. You can run logit or probit if you want, but run a linear probability model as well, so I can tell whether or not anything weird is going on with the regression."

But they just don't believe me.

In essence, students just want to know the "formula" and spend less time thinking and understanding the problem that they are trying to address:

Once students know how to appropriately define a sample, deal with missing values, spot an obviously endogenous regressor, and figure out which explanatory variables to include in their model, then it might be worth having a conversation about the relative merits of probit and linear probability models. Until then, I'm telling my students to use the regress command and, if it makes them feel better, stick "robust" at the end of it.

That`s because their training emphasizes technique over analysis, which is a complaint similar to the one Cullen Roche voiced:

It all comes down to the way that they have been taught econometrics. Most - not all - econometrics classes emphasize statistical theory. Students might run regressions, but often these are canned, ready-made examples, with the parameters of the analysis clearly defined, or straightforward replication exercises.

Econometrics is taught that way for a simple, practical reason: it's easy. When every student downloads his own data, works on his own unique problem, and specifies a novel and original model, each student will need a lot of individual help and attention. The marking cannot be delegated to a TA, because each research question, and each data set, is different, so it is impossible to write down a simple answer key. But spending hours upon hours reading students' first struggling steps at regression analysis is a huge amount of work. It's so much easier to mark a final exam consisting of calculations, short answer questions, and replication of theorems.

Can I just plug in my numbers and get the answer?
Here is another example. A few years ago I wrote a post about the limitations of Altman Z. I wrote that Altman Z score was a useful first cut at solvency analysis for operating companies, but had many industry specific problems:

The main problem with this formulation of solvency risk is that the formula is not suited for many industries. As an example, when I first tried to apply Altman Z I found that many regulated utilities showed up as having high bankruptcy risk.

I found that Altman Z was not industry specific enough to my liking. For instance, low or negative working capital doesn’t score well on Altman Z but some industries can operate with zero or negative working capital. For example, a restaurant gets paid in cash, but their suppliers will generally give them net 30 on their payables and the inventory (food) turns over very quickly.

Another sector that the Altman Z doesn’t analyze is the financial sector. What does “sales” mean for a bank? Financials tend to be highly levered and their operating risks and exposures are not well disclosed.

That post still gets read once in a while because it serves as a useful reference on the Altman Z score. Then, the other day, I get a question asking if "we (can) use Altman Z score to predict (the) banking industry?"

Think about that for a minute, the original Altman Z score assigned weights to different measures of solvency, such as working capital adequacy, EBIT margin, turnover, etc. The weights appeared to have been optimized for operating companies in manufacturing or distribution. Do those weights make sense for a bank? If an analyst had spent just a few minutes thinking about the underlying assumptions of Altman Z; how it relates to the business model of a typical manufacturer and then thought about the business model of a bank; he would instantly have the answer.

These episodes are important lessons to young quantitative analysts and could be inspiration for a MasterCard ad (all figures are approximations):

An undergrad degree (at $30K a year for 4 years): $120K

A graduate degree: $80K

Being forced to think for yourself....priceless

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Tuesday, March 25, 2014

The headlines in China have been nothing short of dismal. Hardly a day goes by without another negative data point, such as the story about a tanking M-PMI (via Zero Hedge):

John Mauldin featured an article by his associate Worth Wray entitled China's Minsky Moment last weekend. I won't go through all of it, but China's problems should be familiar to the readers of my blog. Wray detailed the problems caused by a dwindling supply of cheap labor, debt fueled white elephant infrastructure spending, falling growth to debt increase ratio, which indicates diminishing returns to debt fueled growth, and so on. He concluded:

Over the last 50 years, every investment boom coupled with excessive credit growth has ended in a hard landing, from the Latin American debt crisis of the 1980s, to Japan in 1989, East Asia in 1997, and the United States after both the late-1990s internet bubble and the mid-2000s housing bubble.

The lesson is always the same, and it is hard to avoid. Economic miracles are almost always too good to be true. Broad-based, debt-fueled overinvestment (misallocation of capital) may appear to kick economic growth into overdrive for a while; but eventually disappointing returns and consequent selling lead to investment losses, defaults, and banking panics. And in the cases where foreign capital seeking strong growth in already highly valued assets drives the investment boom, the miracle often ends with capital flight and currency collapse.

John and I talk about China constantly and always reach the same conclusion. We really have no way of knowing whether the country will suffer a modest slowdown or a hard landing, but we both agree with George Soros that “The major uncertainty facing the world today is not the euro but the future direction of China.”

You get the idea of the general tone.

A Minsky Moment?
Is China on the verge of a Minsky Moment where growth collapses?

Events don't always evolve in a straight line. Consider how the Chinese leadership might react in reaction to the recent news about bank runs:

Hundreds of people rushed on Tuesday to withdraw money from branches of two small Chinese banks after rumors spread about solvency at one of them, reflecting growing anxiety among investors as regulators signal greater tolerance for credit defaults.

For now, the minor panic has occurred in smaller banks:

Chen Dequn, a resident in Yandong, just outside Yancheng, said she saw a crowd of about 70 to 80 people gathering in a branch of Sheyang Rural Commercial Bank in her town on Tuesday.

"At the moment there are about 70 or 80 people in there. Normally there'd only be about 10," she told Reuters by telephone.

Officials at another small bank, Rural Commercial Bank of Huanghai, said they had faced similar rushes by depositors, triggered by rumors of insolvency at Sheyang.

"We will be holding an emergency meeting tonight," an official at the bank's administration office told Reuters, but declined to comment further.

As well, protests have sprung up over falling prices as stresses appear in the property market, (via Zero Hedge):

Hell hath no fury like a woman scorned or, it seems, like a Chinese real estate speculator who is losing money. After four years of talking (and not doing much) about cooling the hot-money speculation that is the Chinese real-estate bubble (mirroring the US equity market bubble since stock-ownership is low in China), the WSJ reports that the people are restless as the PBOC actually takes actions - and prices are falling. With new project prices down over 20%, 'homeowners' exclaim "return our hard-earned money" and "this is very unfair" - who could have seen this coming?

Stimulus on the way?
The current rhetoric is about focusing on reform and to transition to a market based economy and to avoid the mistakes of the past. CNBC reported that Vice Finance Minister Zhu Guangyao stated that, even if they were to embark on a new round of stimulus, they would not repeat the mistakes of the past, i.e. credit-fueled infrastructure growth. However, you have to read between the lines (emphasis added):

Amid growing talk that China may take steps to stimulate a slowing economy soon, the country's vice finance minister told CNBC that Beijing would be careful not to repeat past mistakes.

Last week, China's Premier Li Keqiang said the government should roll out measures as soon as possible to stabilize growth and boost domestic demand, China's state news agency Xinhua reported.

Vice Finance Minister Zhu Guangyao told CNBC in an exclusive interview on Sunday that authorities would take a cautious approach and was mindful of the negative impact stimulus has had on the economy in the past.

What is the solution to infrastructure spending? CNBC reported that Beijing has unveiled an urbanization plan, a solution which was endorsed by the World Bank (emphasis added):

Urbanization of China's population has become one of the most important elements in the mainland's shift toward domestic consumption and away from investment-led growth, said Sri Mulyani Indrawati, chief operating officer at the World Bank.

"Chinese leaders recognize the inefficiency and (are aiming for) less reliance on investment," she told CNBC from Beijing at the launch of a World Bank report on urbanization. "Urbanization has become one of the most important parts of shifting the growth model," she said.

She expects the shift will require a lot of policy adjustment, with reforms needed on land policy, including imposing a property tax to substitute revenue for local governments to provide services for their cities' populations. Local governments have been relying on revenue from selling land to convert it into urban space, she noted.

"To maintain [economic] growth at 7.5 percent, [with] better quality and more inclusive, the change is really needed," she said. "They have to change the ecosystem. That is not only going to require the fiscal space, or the ability to finance it, but also the ability to provide those services to many of the migrants moving from the rural to the city area."

A report from the FT gives further details on the urbanization plan. How is this different from the same-old-same-old infrastructure spending approach?

As part of the planned infrastructure construction, the government plans to ensure that every city in China with more than 200,000 residents will be connected by standard rail and express roads by 2020, while every city with more than 500,000 residents will be accessed by high-speed rail.

New airports will be built to ensure that the civil aviation network covers about 90 per cent of China’s population.

The plan also calls for the redevelopment of 4.75m household units in rundown shantytowns this year alone, with an expected total cost of Rmb1tn ($163bn), according to state media reports.

The FT article detailed the real agenda of the Chinese leadership:

Over the longer term, China’s leaders want to shift the country’s growth model to make it less infrastructure driven and more reliant on services and consumption, but they insist that they must keep investment levels high in the short term to guarantee employment and political stability.

Bottom line: When push comes to shove, employment and political stability trumps everything else. As growth slows and stresses start to appear in the financial system, expect Beijing to unveil another round of stimulus based on credit driven infrastructure spending their urbanization initiative. As well, watch the New China-Old China pair trade and expect it to reverse temporarily in favor of the financials at the expense of the "New China" consumer spending oriented companies.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Sunday, March 23, 2014

This is another post in the series about the question of whether we are experiencing a brand new secular bull market before (see my previous post New all-time highs = Secular bull?).

P/E are elevated
The struggle I've had is that secular bulls typically don't start at the kinds of elevated valuation levels. Here is a chart of SP 500 P/E ratios from Chart of the Day that goes back to the start of the 20th Century. Note that P/E ratios are at the top of their historical range, especially if we were to exclude the anomalous episodes of the Tech Bubble period and the Lehman Crisis.

In short, P/E ratios are elevated today. They aren't stupidly high, but there is no question that they are above average. As another point of reference, James Montier of GMO (via Zero Hedge) believes that the stock market is 50-70% overvalued. A 50-70% adjustment would put the P/E ratio in the low teens - which is roughly in the middle of the historical range.

What about interest rates? The inverse of P/E is E/P, or earnings yield, which should be compared to the prevailing interest rates of the time. (This approach, by the way, forms the theoretical basis for the so-called Fed Model.) Here is a chart of 10-year Treasury yields going back to 1918, courtesy of Global Financial Data. The other comparable episode of low bond yields occurred during the period from the late 1930's to the mid-1950's.

10 year Treasury yields

The late 1930's to early 1950's analogue
Now look at this long term chart of the Dow. The stock market was range bound for most of that period until a new secular bull was launched about 1952:

Dow Jones Industrial Average

Here's my problem. The early 1950's were marked by extremely low P/E ratios in the single digit range, while today we are seeing P/Es in the high teens. The early 1950's was marked by a low interest rate regime, just as we have today. If this is truly the start of a new secular bull, how can we expect stock market gains that are typically seen in past episodes?

When he puts it all together, my inner investor thinks that, if we are indeed seeing a new secular bull market, the extraordinary measures undertaken by global central banks in the wake of the Lehman Crisis has front-end loaded many of the gains to be realized in this bull.

True, the major averages have convincingly broken out to new all-time highs and it looks like a secular bull from a technician's viewpoint. However, valuation analysis suggests that this market is unlikely to see the same kinds of gains.

This market isn't a bull. It is, at best, a secular steer.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Thursday, March 20, 2014

Fed chairs are under intense scrutiny for their utterances. I can remember an interview with Paul Volcker who said that he felt so much under the microscope that when he went out to a restaurant, he felt compelled to say, "I'll have the steak, but that doesn't mean that I don't like the chicken or the lobster."

In the wake of Janet Yellen's uttering the phrase "around six months", both stock and bond markets sold off. While the major equity averages rallied the next day to recover virtually all of their losses, the Treasury market remained mired in the red compared to pre-FOMC announcement levels as of the close on Thursday.

Most analysts were either neutral or dovish
So was the market sell-off an overreaction to what amounted to a rookie mistake? Most of the analysis that I've read had a neutral or slightly dovish take to the FOMC statement and Yellen press conference. Here are some examples.

This raises several questions:
1) When does six months end?
2) Is this data dependent?
3) Is this new news?

The answer to the first question is July 2015. McBride outlined a schedule of FOMC meetings and counted forward six months:

Based on this schedule, the FOMC will conclude tapering as of January 1, 2015. So six months would be around July 1, 2015.

The answer to the second was yes. Of course it's data dependent. The answer to the third is no, at least to McBride:

Maybe it surprise some participants, but Yellen's comment fit previously released projections, so it really shouldn't be too shocking.

Data dependent, not date-dependent
Cardiff Garcia at FT Alphaville thought that Yellen was trying to convey the ambiguity and data dependence of the forecast:

[S]he wanted to emphasise that this too would be data-contingent, not calendar-based. Markets seem to have ignored the caveats. That is the danger of being too explicit when specificity isn’t called for. Bernanke made a similar mistake last summer in saying that “when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 per cent” — only to walk it back shortly after. Don’t be surprised if Yellen also clarifies further what she meant by the “six months” comment, and soon.

Greater uncertaintyJon Hilsenrath had a slightly different take on the situation. The markets reacted the way they did because of heightened uncertainty:

What she does seem to have done, however, is awaken investors to risks to the interest rate outlook. Since last September investors had become remarkably secure in their belief that the Fed wouldn’t budge on interest rates until mid- to late-2015. The Fed’s many reassurances since September formed and underpinned that conviction. Ms. Yellen and her colleagues have introduced a sliver of uncertainty around the edges of these calculations. Officials still don’t expect to move until next year. They still expect to move rates up very gradually once they start and to keep rates well below normal levels of 4% far into the future. But as they like to remind people from time to time, these decisions aren’t on a preset course.

Growth risks are to the downside
Jan Hatzius of Goldman Sachs has a more dovish outlook (via Business Insider):

...we still think that rate hikes are far off. First, we do not think that Yellen meant to send a strong signal of a shift in the reaction function. Second, while we agree that the most likely path for growth is a pickup to a 3%+ pace, the risk to this forecast is on the downside. Third, we expect a more gradual return to 2% inflation than the FOMC. Fourth, we see a significant risk that a tightening of financial conditions in the run-up to the first rate hike will delay the first hike, much as last summer's "taper tantrum" delayed the actual move to QE tapering.

Our central forecast for the first hike remains early 2016, although the risks now tilt in the direction of a slightly earlier move.

To summarize, the consensus is that the market over-reacted to the downside. If that's the case, watch for Fed officials scrambling to get into damage control mode in the days and weeks to come.

If I am right on that score, watch for the Treasury market to rebound - and soon.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Cash-strapped Chinese are scrambling to sell their luxury homes in Hong Kong, and some are knocking up to a fifth off the price for a quick sale, as a liquidity crunch looms on the mainland.

ZH went on to tell us about the terrible cash problems that Mainland Chinese buyers were facing:

Wealthy Chinese were blamed for pushing up property prices in the former British territory, where they accounted for 43 percent of new luxury home sales in the third quarter of 2012, before a tax hike on foreign buyers was announced.

The rush to sell coincides with a forecast 10 percent drop in property prices this year as the tax increase and rising borrowing costs cool demand. At the same time, credit conditions in China have tightened. Earlier this week, the looming bankruptcy of a Chinese property developer owing 3.5 billion yuan ($565.25 million) heightened concerns that financial risk was spreading.

"Some of the mainland sellers have liquidity issues - say, their companies in China have some difficulties - so they sold the houses to get cash," said Norton Ng, account manager at a Centaline Property real estate office close to the China border, where luxury houses costing up to HK$30 million ($3.9 million) have been popular with mainland buyers.

...blah, blah, blah...

The $2 million dog
As an antidote to ZH's all-disaster-all-the-time tone, CNBC reported that someone in China had bought a puppy for just under USD 2 million:

A golden-haired Tibetan mastiff puppy has reportedly been sold for a whopping $2 million in China, potentially making it the world's most expensive dog.

The pup was sold at a premium pet fair in the eastern province of Zhejiang on Tuesday, fetching 12 million yuan ($1.95 million), according to AFP, which cites a report in Chinese newspaper Qianjiang Evening News.

The £1 million dog (circa 2011)

Observant readers will recall the news story in March 2011 which reported the then eye-popping price of £1 million for a golden-haired Tibetan mastiff puppy:

"He is a perfect specimen," said Mr Lu, who runs the Tibetan Mastiff Garden in Laoshan, near the eastern Chinese city of Qingdao. "He has excellent genes and will be a good breeding dog. When I started in this business, ten years ago, I never thought we would see such a price."

Mr Lu said the details of the sale were confidential, but revealed that the buyer, who paid 10 million yuan (£945,000), was a multi-millionaire coal baron from the north of China.

Why so much for a dog? That's because the male puppy was a good investment - for breeding stock:

"I could see he loved the puppy, or I would not have sold him," he added. "The buyer told me he thought he was a good investment. As a male dog, he can be hired out to other breeders for as much as 100,000 yuan a shot. He could recoup his money in just a couple of years."

I am glad to see top quality dogs are going up in value, which is an indication of rising affluence in China. £1 million in March 2011 was equivalent to roughly USD 1.6 million at the time. Now a top dog fetches USD 2 million.

This shaggy dog story begs the question: If these kinds of prices are being paid for dogs, is China truly crashing from a liquidity crunch?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Tuesday, March 18, 2014

This is Stanley Fischer, the not yet confirmed nominee to be Fed vice-chair, former head of Israel's central bank and former thesis advisor to Ben Bernanke and Mario Draghi, voicing an opinion about potential Fed policy [emphasis added]:

Stanley Fischer, the nominee to be Federal Reserve Chair Janet Yellen’s top lieutenant, said governments must devise measures to ensure taxpayer dollars are never used again to save a failing bank.

“It is critical to develop now the tools needed to deal with potential future crises without injecting public funds,” Fischer said in the text of remarks prepared for a speech today in Stanford, California.

Efforts to avert future crises are driven “by the view that we should never again be in a situation in which the public sector has to inject public money into failing financial institutions in order to mitigate a financial crisis,” he said.

Fischer is a former central banker and the breed is normally reserved in their public statements. However, his stature as an elder statesman does allow him some leeway and such views no doubt holds a great deal of sway in the halls of the Federal Reserve.

I was always of the opinion that the bankers should never have been bailed out they way they did. The Swedish solution of offering a nationalization solution if a bank could not find private financing was the better solution. At the height of the crisis, the funds allocated to TARP could have bought the equity of the entire BKX Bank Index.

While such a change in policy amounts to shutting the barn door after the horse has bolted, it nevertheless amounts to a brand new direction at the Yellen Fed.

Suddenly, the nuances of the FOMC statement seems insignificant compared to this development. Wow!

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Monday, March 17, 2014

Asia Confidential recently wrote a courageous and contrarian article to buy China, though with the usual caveats. They acknowledged the risks, but justified the "buy" recommendation on the basis of valuation:

Our focus today though is whether China stocks qualify as potential opportunities following their recent correction. It’s our view that these stocks do offer attractive prospective returns. Not outstanding, but attractive. In other words, long-term investors should consider accumulating them at current levels.

Yes, China’s economy is deteriorating. I’ve been consistently negative on this economy over the past 18 months. But the argument here is that a credit bust is now largely factored into stock prices. The Chinese stock market is down two-thirds from 2007 highs, investor sentiment is at multi-year lows, valuations are close to decade lows and bank prices have more than discounted a crisis.

Sure, there are plenty of risks to this call. Stock market corrections normally end with sharp falls and that may be ahead of us. Events such as further trust loan defaults and a serious property downturn (the next domino to fall) could further dent investor confidence. And the list goes on. Ultimately, however, these risks need to be weighed against the price on offer. In the case of Chinese stocks, the price appears reasonable.

The focus on the long side is on the so-called "New China" consisting of companies exposed to the consumer and away from banks, where much of the credit risk resides:

The focus of any buying of China stocks should be on what I term “new China”. That is, stocks in sectors which should benefit from the country’s switch to a more consumption-driven economy.

Internet stocks should be the first port of call. They have many structural tailwinds. China’s internet penetration rate stands at just 40%, about the level of the US in 2000. Only 25% of households have a personal computer, indicating ample room for growth. Lastly, the smartphone installed base, currently at close to 300 million, is expected to hit 400 million in 2014...

[snip]

The consumer sector is also one to like. While consumer staples are expensive, retailers aren’t. While the latter faces considerable short-term headwinds, some are priced for it. I like Giordano, a pan-Asian discount retailer with significant exposure to China. It has a great track record and sports a single digit price-to-earnings ratio and sustainable dividend yield of +7%.

Finally, Chinese insurers operate in an under-penetrated industry which should benefit as incomes improve. PICC has a stronghold on property and casualty insurance and is reasonably priced.

A pair trade with reduced market risk
Though I am somewhat skeptical of any company in the financial sector because of looming credit, this investment thesis brings up an idea of a pairs trade. How about buying "New China" (consumer sectors) and shorting "Old China" (finance and infrastructure)?

On the long side, one ETF to consider is PowerShares Golden Dragon Halter USX China Portfolio (PGJ), which is overweight in Technology and virtually nothing Financials:

The pairs chart tells the story. This pair had been range-bound until PGJ staged a relative breakout against FXI last summer and it has been on a tear ever since. While it is somewhat extended, this is one way to benefit from the stated government objective of rebalancing growth from credit driven infrastructure growth to consumer-led growth.

The pairs trade chart shows a high degree of volatility and it is obviously not without risk. However, it may be an interesting way of being exposed to China;s growth with reduced market risk.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Sunday, March 16, 2014

Well that didn't take long! The stock market goes down for a week and the bears are coming out of hibernation. We are starting to see more posts like Hale Stewart's More signs of a US equity market top. For bulls and bears alike, it's time to take the weekend, relax, and review the upside and downside risks in the broad market averages. Here is what the US equity market seems to be worried about, in no particular order:

Ukraine/Crimea

Chinese slowdown and financial tail-risk

Falling corporate earnings

I will examine each of these issues one by one and conclude this post with a assessment of the technical picture for US equities. In essence, I am trying ask the question, "What could go wrong and how much of it is the market?"

Ukraine/Crimea: Market wildcard
Much has written about the Crimean situation and this represents the true market wildcard. The news that Crimeans voted to rejoin Russia was no surprise, the key question is what happens next. The most balanced and reasoned view that I have seen comes from Oleg Babinov of The Risk Advisory Group (via Moscow Times). Babinov wrote that much will depend on what kind of sanctions are imposed by the West:

If Russia does not rush in to incorporate Crimea as its "administrative unit" and the sanctions are limited to its dropping from Group of Eight and some limited visa sanctions and asset freezes for politicians and businessmen who are directly involved in separatist activities, Russia's response would be relatively small-scale. If this is the case, there will be little effect on investors, except those who may be involved in cooperation with Russian companies in the field of military technology — but this is possible only if the U.S. and the European Union do not decide to freeze cooperation with Russia in this field.

But if sanctions are applied to Russian state-owned companies and banks, Russia might want to retaliate by freezing foreign companies' accounts here. There was an announcement that the constitutional law committee of the Federation Council has invited legal experts to study whether such sanctions would be legal, but no draft law has been produced yet.

Babinov believes that Putin cares more about geopolitics than economic sanctions. We are seeing in effect an assertion of a Russian Monroe Doctrine (my interpretation, not his):

President Vladimir Putin is ready and willing to have a confrontation with the West of the scale that would not have been imaginable during the previous 14 years of his presidency.

He considers a pro-Western Ukraine to be a strategic challenge to Russia and a likely new member of NATO on Russia's border. Putin no longer trusts Western politicians and seems to have concluded that Russian interests will be taken into account only, if and when it has a strong negotiating position.

Putin sees a strong chance of winning in the political confrontation, and this is probably more important for him now than foreign investors.

In an interview with Der Spiegel, Fiona Hill of the Brookings Institute confirmed my Russian Monroe Doctrine thesis and believes that Putin views EU encroachment in the Ukraine as an existential threat:

Putin is not interested in an off-ramp right now. We are trying to offer him a face-saving gesture on the basis of our assumption that he wants to save face internationally. But that's wrong. Putin actually sees the ongoing developments in Ukraine as an existential threat. He has carefully calculated the costs and the risks of his steps. Now he is obviously going to wait and see how people react to the outcome of this referendum on Sunday.

Christopher Clark, professor of Modern European History at the University of Cambridge, wrote in Der Spiegel that the Europeans have begun to admit that they miscalculated when they got overly enthusiastic about the enthusiastic pro-EU popular uprising in Kiev, without giving weight to the geopolitical situation:

In a recent statement for a news program, German Foreign Minister Frank-Walter Steinmeier conceded that the EU foreign ministers (himself included) had been too quick during the early days of the crisis to engage with the Ukrainian opposition and too slow to take account of the larger geopolitical issues that are entangled with the crisis. This remark exhibited a level of self-critical reflection and a readiness to adjust to new developments that would have been completely alien to his early twentieth-century counterparts.

Today, Western Europe finds itself boxed in. While it remains supportive of the principles of self-determination, it is also cognizant of Russia's perceived needs of the security of its borders (the Russian Monroe Doctrine). The question then becomes one of how the West and Russia can each save face and achieve their respective objectives without appearing to back down?

Strictly from a coldly logical position (and I am not advocating this, I should add), in many ways it is in Kyiv’s interests for Moscow to steal Crimea, and turn it into some pseudo-state or new part of the Russian Federation. Ukraine loses a sunny peninsula, but also a distinct drain on the state’s coffers (the Crimean economy is not great, and the region receives net subsidies from the centre). It sheds the most troublesome and Russophile of its regions, one which has been a turbulent locus of trouble for Kyiv for most of post-Soviet Ukraine’s history. It also gets concrete proof of the threat it faces from Russian bullying and probably accelerated and solicitous assistance from the US, EU, NATO, etc. It also validates every Ukrainian fear about Russia.

A Washington Post article confirmed the analysis that absorbing the Crimea will be costly for Russia:

Ever since Ukraine became a sovereign nation in 1991, Crimea has received more subsidies from the central government than it pays in taxes, and that would probably continue on Moscow’s tab. Russian levels of social spending are higher than Ukraine’s, and economists predict that Moscow may have to pay about $3 billion a year to support the region. On Friday, Russia committed to at least $1 billion for the upcoming year, even without annexation.

Crimea receives nearly all its electricity and drinking water from Ukraine, and Russia will need to build new infrastructure — including a long-planned bridge — to link Crimea directly to the Russian mainland. Until that is complete, it will have to pay Ukraine for the utilities.

An analysis done by Russia’s Moskovsky Komsomolets newspaper suggested that absorbing Crimea might cost Russia $20 billion during the next three years.

Indeed, Canada's Globe and Mail featured an interview with a member of Crimea's intelligensia, or creative class, explaining the losers of a pro-Russia referendum win would be the creative class, while the winners would be those supported by the state:

“We have a joke here: Who wins if Crimea becomes part of Russia? The pensioners, the civil servants and the military. Who loses? The creative class, the middle class,” Mr. Kostinsky sighs.

Bulls and bears alike should decide for themselves what has already been priced by the market. They should also heed Oleg Babinov's advice to see the extent of Western sanctions and Moscow's response in the days and weeks to come.

China: A Beijing Put?
The second major worry for investors has been the rising prospect for an economic slowdown in China. Slowing growth would expose the Chinese financial system to rising levels of tail-risk. The press has been full of stories about a Chinese slowdown and I won't go through all of them. This Financial Post is story entitled 11 ugly signs confirming China's dramatic slowdown is an excellent example.

Despite the signs of falling growth, I reiterate my warning to China bears that, when push comes to shove, Beijing has shown a pattern of relenting with stimulus programs when faced with the prospect of instability (see Time to short China?). Premier Li Keqiang confirmed the bias for stability when he stated that government placed greater emphasis on employment and quality of life issues over numerical GDP growth targets [emphasis added]:

Speaking at a news conference in Beijing on Thursday, Premier Li Keqiang said that job growth and quality-of-life issues like the battle to reduce air pollution took precedence over the headline growth figure. China needs to create 10 million jobs, he added. He also said that further bond defaults were inevitable, as China remakes its financial system and rules. But he added that the government would do its best to ensure that bad debt did not roil the broader system.

In some ways, the current market turmoil over potential defaults represents a health adjustment as China is moving towards market signals to properly price risk. Bloomberg reported that Chinese default risk has risen beyond Ireland's. Indeed, the pricing of my so-called Chinese canaries, or Chinese banks listed in HK, has seen a bifurcated path. While the an index of smaller banks have fallen to a critical support zone, which indicate some degree of caution is required, the index of the Big Four state owned banks remain relatively healthy compared to their own history.

When I put it all together, it appears that Beijing is trying to reform policies so that market forces become more dominant, but not so dominant that it would allow a disorderly market unwind. It has therefore implicitly signaled that a "Beijing Put" is in place for the markets.

Corporate earnings
Lastly, falling Street EPS estimates in the past few weeks have been a headwind for stock prices. The recent weakness in macro-economic indicators have fed through to falling Street estimates. Fortunately for the bulls, the bout of weakness in high-frequency economic releases may have been overdone. The chart below of the Citigroup Economic Surprise Index (in orange) has retreated to levels where it has rebounded in the past. If you are taking a bearish view on equities, then you are not just betting that the economic acceleration embraced as the market consensus in late 2013 was a false dawn, but that economic growth is actually starting to decelerate below 2%.

New Deal Democrat's review of last week's economic releases concluded that no economic downturn is imminent [emphasis added]:

This week is a continuation of the last few week's trends. Last year's weakness in the long leading indicators has fed through into the short leading and coincident indicators, although there was improvement in many this week. Because the recent weak consumer spending leads jobs, I expect that job reports in the next several months may be weak. At the same time, the long leading indicators did not roll over and have recently rebounded somewhat and suggest this will not lead to actual contraction.

There was more good news for the bulls on the earnings front. Brian Gilmartin, who keeps a diligent watch on the progress of EPS estimates, reported that they ticked up last week [emphasis added]:

Per Thomson Reuters, the “forward 4-quarter” earnings estimate for the SP 500 actually rose $0.02 last week from $118.87 to $118.89...

More importantly, the year-over-year growth rate of the 4-quarter estimate rose to 6.19%, from 6.11% last week and 6.05% two weeks ago. In my opinion it needs to move over 8% to start to think we can see 10% growth in 2014.

So far, so good, on the EPS growth outlook.

However, no discussion of the corporate earnings outlook without a highlight of Mark Hulbert's most recent warning on insider selling:

Corporate insiders are more bearish than they have been in almost 25 years. That isn’t good news for the stock market, since these insiders — corporate officers and directors— know more about their companies’ prospects than the rest of us.

The high level of insider selling is a concern and something to keep on your radar, but insider buying has historically been a more powerful signal than insider selling. Indeed, the last time Hulbert sounded the alarm on insider selling was in December 2012, just before the stock market continue to rally to further recovery highs.

Technical market review
To finish my review, I conclude with a technical market assessment of the US equity market. The SPX has fallen, but it has descended to a level where there is ample technical support, such as the 50 day moving average at about 1128 level.

The advance-decline line remains in an uptrend, though it did violate a support level.

Other breadth measures remain constructive. I constructed an equal weighted composite of the relative performance of the Russell 2000, the SP 600 and the equal weighted SP 500 against the SP 500 as a broad measure of the small cap vs. large cap breadth. Small cap stocks remain in a relative uptrend against large caps that began in mid-2012. Moreover, they recently staged an upside relative breakout and that breakout has held up.

As well, the map of market leadership remains in the bulls' favor. The chart below shows the relative performance of the defensive sectors (in black), which consist of consumer staples, utilities and telecom (health care was not included as sector performance has been skewed by the biotechs, which have been on a tear) against the SP 500. The SP 500 performance is shown for reference in purple. Note how past market tops have been preceded or coincidental with the outperformance of defensive stocks. Today, while defensive stocks have ticked up a bit, they remain in a relative downtrend.

In the short-term, the market is oversold and the risk is tilted to the upside. This depiction of the equity-only put-call ratio (blue=5 day moving average, red=21 dma) is a contrarian indicator. It shows that short-term option trader sentiment is at or near a crowded short reading and medium term sentiment to be roughly neutral.

Positive short-term seasonal and cyclical patterns
Of secondary consideration is a number of positive seasonal and cyclical patterns for stock prices. I wrote a somewhat speculative post last week about the 20-week cycle which suggested a cyclical low see Cycles in the eye of the beholder and Cycle model update). Ryan Detrick of Schaeffer's Research highlighted the typical March seasonal pattern. Note how we are about to enter into a positive seasonal period for stocks:

In a separate post, Detrick also pointed to the fact that the upcoming week is option expiry week. Though returns have been volatile, stock prices have had a bullish bias:

What bet are you making?
To summarize, bulls and bears have to understand the nature of the bet that they are making if they take a directional bias in the current market environment.

Equity markets have taken a hit mainly on worries over Ukraine/Crimea and China. The fear level is a tad on the high side, which doesn't mean that they can't get even higher on negative developments. I believe that China fears are overblown for the reasons that I already cited, but the geopolitical situation with the Crimea is a wildcard. Longer term, the outlook for equities appear benign as positive breadth and rising EPS expectations are supportive of higher stock prices.

Bearish traders have to know that if they get short or remain short here, they are betting mainly on geopolitical tensions getting out of control. In effect, they are betting that the world is on the edge of a precipice and it's ready to go over. In addition, they are betting on a neutral or hawkish statement from an FOMC meeting on March 19 from a Fed headed by a new chair with a dovish reputation.

By contrast, bulls are betting that someone in Moscow, Washington, Berlin, etc. doesn't miscalculate and deepen the crisis. The bulls' underlying view is that the stock market just hit a pothole, but it's not going to slide over a cliff.

Traders have to decide, in effect, on what kind of bear they encountered last week.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

Saturday, March 15, 2014

New Deal Democrat wrote a highly sepeculative post about the mysterious disappearance of flight MH370. He outlined three scenarios. The most intriguing was the third:

3. The plane was deliberately diverted by a pilot or hijacker and landed somewhere else, with a further act having already been planned.

What we have learned in the last several days has only strengthened the likelihood of scenario number 3. Most importantly, the plane was equipped with a beacon that would send a signal if the plane was about to crash into the ocean. The beacon never went off.

In the last 24 hours, more and more officials are saying outright that the disappearance of the airplane was a deliberate act. In fact, as of this morning it appears to be emerging that a series of deliberate acts were undertaken to minimize the likelihood that the plane could be tracked on radar.

So the narrative seems to be focusing more and more in the direction of scenario 3.

But if scenario 3 is correct, then the persons who planned it are not the underpants gnomes. You know the meme: Step (1) steal underpants. Step (2). ???? Step (3) Profit!

No, these persons already have a plan for Step 2. The did not simply park the plane in a hangar somewhere, high five one another, and over a round of celebratory drinks, start discussing what they might be able to do with the plane at some later date.

IF scenario 3 is the correct scenario, then the preparations to carry out Act 2 are already in motion.

What would be a big enough Event planned for Act 2 to justify all of the planning necessary to actually commandeer a commercial airliner in the manner that took place one week ago? Whatever it is, it must be really Big.

The events of 9/11 exposed a vulnerability of the Air Traffic Control (ATC) system. ATC could not track one of the hijacked airliners among the myriad of planes in the air because it had turned off its transponder. That episode begged the question, "If Russian Backfire bombers approached the US coast and was preparing to fire cruise missiles at Washington, did NORAD expect the Backfires to be transmitting transponder signals?"

The disappearance of MH370 exposed another flaw in global ATC. When an aircraft is in international airspace over the ocean, they are not under the control of any country's ATC system. Airliners, however, do fly commonly specified routes at specified altitudes as then cross the ocean. When they enter a country's airspace, they then check in with local ATC, who then guides them.

Imagine the following scenario:

A group of terrorists hijack an airliner, turn off its transponder and other communication systems, and spirit the plane to places unknown.

The plane lands and it is re-loaded with high explosives, which makes it an even more powerful bomb than the hijacked 9/11 planes.

The plane takes off again and blends into traffic on an international route.

When it approaches the airspace of the target country, it identifies itself as a fictitious flight.

The pilots then flies into its target and the flying bomb wreaks havoc on whatever it hits.

Given its likely direction of flight, which is currently postulated in a westward direction from Malaysia, a likely target under this scenario would be a oil facility in the Middle East. Imagine a flying bomb crashing into a large refining or oil export facility and taking out a significant portion of global production and you get the idea of the global impact of such an act.

While this scenario would make a good movie, its plausibility depends a number of key assumptions:

There are enough skilled, dedicated and well-trained volunteers to hijack and take over an airliner (step 1 as postulated by New Deal Democrat).

The ability to land a 777 somewhere undetected by local authorities;

The facility to deal with the passengers, either dead or alive, after landing;

The ability to refuel a 777 at the airport which the plane landed;

The ability to disable the aircraft engines' software to "ping" the satellites with data once the aircraft has re-started on the way to its final mission; and

An accomplice to file a false flight plan for the plane on its flight. ATC generally knows the schedules of airliners coming into its airspace and the appearance of an unknown plane with unusual call signs would set off warnings.

Such an operation would require a high level of planning and coordination. It's very difficult to just land a 777 somewhere out of the blue, hope that it won't be noticed by somebody and refuel it without detection. Any state that allows its facility to be used for such an operation would be branded a sponsor of terrorism and suffer the consequences.

What's more, what are the chances that an organization, however nefarious, could pull off such an operation involving so many people without arousing the suspicion of one or more intelligence services?

The disappearance of MH370 remains a mystery, but I suppose that such a scenario could be the inspiration for a book or screenplay.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

FXI, the Chinese equity ETF, has been in a downtrend and breached an important short-term technical support level.

What's going on? Is this time to start shorting China and China-related plays?

Extend and pretend, or...

I have seen some traders enthusiastically jump into the bear camp based on these data points, but I would caution about getting overly bearish too early on China. As I wrote before, you have to watch out for the policy response to news of weakness (see Will Beijing blink yet one more time?):

Beijing has exhibited a pattern of pushing a reform agenda, but unwilling to bite the bullet when critical sectors of the economy get pushed to the edge. If history is any guide, the Chinese leadership will continue talking tough on reform, only to see its initiatives get watered down as they run up against entrenched interests.

Consider what was said (and what was not said) in a recent speech by Premier Li Keqiang (via Reuters):

Li, speaking at a news conference on the final day of China's yearly parliament, hinted Beijing would tolerate slower economic expansion this year while it pushes through reforms aimed at providing longer-term and more sustainable growth.

Beijing has a reform agenda, but stability is also important [emphasis added]:

"We are reluctant to see defaults of financial products, but some cases are hard to avoid," Li said. "We must enhance oversight and solve problems in a timely way to ensure no systemic and regional risks."

You have to read between the lines and understand what was not said. They don't like to see defaults of trust and wealth management products, but Li did not say outright that they would allow all shadow banking products go bust, let market forces assert themselves and eliminate the moral hazard problem. Instead, Li said in so many words that they will take steps to "ensure no systemic and regional risks". In other words, count on more bailouts and stimulus.

Based on Li Keqiang's recent statement, it appears more than likely that the Chinese leadership will blink one more time to play the "extend and pretend" game. Expect them to once more stimulate and rescue the economy should growth slow or financial stresses threaten stability.

Already, a number of analysts are already expecting stimulus measures in light of the recent bout of economic weakness (via Bloomberg) [emphasis added]:

Hong Kong stocks fell and copper extended declines following the data, which came two hours after Premier Li Keqiang indicated he was confident the nation would meet what he said was a flexible growth target of “about” 7.5 percent. The slowdown may test the Communist Party’s commitment to give market forces a bigger role in the world’s second-largest economy while confronting overcapacity, debt and pollution.

“This is a very fast deceleration,” said Yao Wei, China economist at Societe Generale SA in Hong Kong, ranked as the most accurate forecaster of China’s gross domestic product by Bloomberg. “This is really beyond the tolerance of the Chinese government. As a result, I think they will cut the required reserve ratio quite soon or do some easing.”

Such a reduction could happen “within a few days” if the government wants to achieve 7.5 percent expansion, Yao said.

What kind of bear?
I think that China bears should take a deep breath. I agree with Hale Stewart when he rhetorically asked the question "Should we be worried about the latest Chinese data?". He wrote:

So -- what do we make of this weakness? Part of it is probably due to the seasonal impact of Chinese New Year's celebration. For the last three years, early year Chinese data has had similar misses but later rebounded. At the same time, many people have noted that as China tries to rebalance its economy, these type of misses may become more pronounced and numerous. But also note China is still growing at a sharp clip. And even if we see the number dip to the 6% range that's hardly a reason to throw in the towel. While it would be disappointing, it would also be a signal the Chinese economy is beginning to mature and achieve first world status.

I have seen some China bears embrace the idea of short positions in Australian miners and base metals in light of recent copper weakness, but the forecast of an extended decline in mining stocks may be a mirage. If copper is so weak, why is the relative performance of mining stocks against the SPX still range-bound?

Another key indicator of China weakness to watch is the AUDCAD exchange rate. Both Australia and Canada are resource producing economies, but Australia is more China sensitive and Canada is more US-sensitive. China bears should ask themselves why the AUDCAD exchange rate is in an uptrend in light of the recent weakness in Chinese economic data.

For China bears, a word of advice: "Just be sure that the grizzly bear that you are chasing doesn't turn out to be a koala bear."

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

We've moved!

Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

DISCLAIMERThis is not investment advice! I know nothing about you, your risk preferences, your portfolio or your investment horizon. I have no idea whether any of my opinions expressed are suitable for you.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.